Bracing for Sticker Shock

Summary

Podcast Summary: "Bracing for Sticker Shock" Thoughts on the Market with Morgan Stanley | Released July 11, 2025

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Introduction

In the July 11, 2025 episode of Thoughts on the Market, Morgan Stanley's Andrew Sheats and Jenna Giannelli delve into the intricate dynamics of U.S. tariffs and their unfolding impact on market prices and corporate margins. The discussion centers around the perplexing observation that, despite substantial tariff implementations, significant price increases and margin compressions have yet to materialize in official inflation data or adversely affect the resilience of stock and credit markets.

Understanding the Delayed Impact of Tariffs

Andrew Sheats opens the conversation by highlighting the core dilemma: "Where and when are tariffs going to show up in prices and MARGINS?" (00:10). Jenna Giannelli responds by pointing out the critical timing factor. Retailers had already been maintaining substantial inventories—three to four months' worth—prior to the imposition of tariffs, allowing them to absorb early tariff inflows without immediate price hikes or margin squeezes. She states, "retailers were already sitting on three to four months worth of inventory" (01:22), which helped mitigate the initial pressures from the tariffs.

Mitigation Strategies Employed by Retailers

Jenna elaborates on the multifaceted approaches retailers have adopted to counteract tariff-induced costs. These strategies include:

• Inventory Management: Utilizing pre-tariff stock to offset new costs.
• Supply Chain Adjustments: Cancelling or pausing shipments from China and shifting production to other regions.
• Cost Optimization: Negotiating better terms with vendors and adjusting the product mix to favor lower-cost items.

She emphasizes, "retailers we've just seen utilizing a range of mitigation measures" (01:22), showcasing a proactive stance in navigating the tariff landscape.

The Role of Pricing as a Last Resort

Andrew probes deeper into the possibilities of retailers exhausting all other mitigation avenues, leading to price increases as a final option: "So closer is what I would say we're likely not going to see a huge impact in 2Q, more likely as we head into 3Q and more heavily into the all-important fourth quarter holiday season" (03:53). Jenna concurs, predicting that significant pricing adjustments will emerge in the third and fourth quarters, particularly during the holiday season when higher-cost goods flow through the profit and loss statements.

Category-Specific Impacts

The discussion shifts to how different retail categories will bear the brunt of tariff-related costs. Jenna highlights that:

• Deflationary Categories: Apparel and footwear may struggle to pass on higher costs without strong brand leverage.
• Durable Goods: Sectors like home goods, sporting goods, and furniture will find it challenging to implement price hikes.
• Staples: Categories such as beauty and personal care products are expected to handle price increases more smoothly due to their non-discretionary nature.

She notes, "Where it's going to be less of an issue is in our staples universe or in what we'd put as less discretionary categories like beauty, personal care" (05:12).

Market Implications and Future Projections

Andrew connects the micro-level discussion to broader macroeconomic trends, referencing Morgan Stanley economists' forecasts that inflation—currently modest—may rise again in the latter part of the year. This resurgence in inflation could deter the Federal Reserve from cutting interest rates as initially anticipated. Jenna adds that recent tariff announcements, especially those targeting Southeast Asia, exceed management teams' expectations and could significantly impact retail earnings. She projects, "consensus expectations for calling for EBITDA in our universe to be down around 5% year over year" versus a potential "15% year over year on a gross basis" when current tariff rates fully take effect (07:50).

Recent Developments and Final Insights

Jenna points out that recent tariff rates, particularly those effective from August 1st, are harsher than what many retailers had anticipated. This escalation suggests that further earnings revisions are likely, intensifying the discrepancy between current consensus estimates and potential outcomes under the new tariff regime.

Conclusion

Andrew wraps up the discussion by underscoring the growing uncertainty in the market due to escalating tariffs and their delayed yet potentially profound impact on retail pricing and corporate margins. He highlights the delicate balance retailers must maintain between mitigating costs through various strategies and the eventual necessity of passing some costs onto consumers, which could have broader economic implications.

Jenna reiterates the significance of the upcoming quarters, especially the holiday season, as pivotal moments where tariff impacts are expected to crystallize, potentially leading to more pronounced inflationary pressures and reshaping market dynamics.

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Notable Quotes:

• "Where and when are tariffs going to show up in prices and MARGINS?" — Andrew Sheats (00:10)
• "Retailers were already sitting on three to four months worth of inventory" — Jenna Giannelli (01:22)
• "retailers we've just seen utilizing a range of mitigation measures" — Jenna Giannelli (01:22)
• "this last stop it will be to try and raise price" — Jenna Giannelli (03:53)
• "consensus expectations for calling for EBITDA in our universe to be down around 5% year over year... should be down around 15% year over year" — Jenna Giannelli (07:52)

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This comprehensive analysis provides valuable insights into the nuanced effects of tariffs on the retail sector, emphasizing the interplay between corporate strategies and macroeconomic trends. For investors and market enthusiasts, understanding these dynamics is crucial for anticipating future market movements and making informed decisions.

Transcript

[Andrew Sheats]

Welcome to Thoughts on the Market. I'm Andrew Sheats, head of Corporate Credit Research at Morgan Stanley.

[Jenna Giannelli]

And I'm Jenna Giannelli, head of US Consumer and Retail Credit Research.

[Andrew Sheats]

And today on the podcast we're going to dig into one of the biggest conundrums in the market today. Where and when are tariffs going to show up in prices and MARGINS? It's Friday, July 11th at 10:00am in New York. Jenna, it's great to catch up with you today because I think you can really bring some unique perspective into one of the biggest puz that we're facing in the market today. Even with all of these various pauses and delays, the US has imposed historically large tariffs on imports and we're seeing a rapid acceleration in the amount of money collected from those tariffs by U.S. customs. These are real hard dollars that importers or somebody else are paying. Yet we haven't seen these tariffs show up to a significant degree in official data on prices, with recent inflation data relatively modest. And overall stock and credit markets remain pretty strong and pretty resilient, suggesting less effect. So are these tariffs just less impactful than expected or is there something else going on here with timing and severity? And given your coverage of the consumer and retail sectors, which is really at the center of this tariff debate, what do you think is going on?

[Jenna Giannelli]

So yes, this is a key question and one that is dominating a lot of our client conversations at a high level. I'd point to a few things. First, there's a timing issue here. So when tariffs were first announced, retailers were already sitting on three to four months worth of inventory just due to natural industry lead times and they were able to draw down on this product. This is mostly what they sold in 1Q and likely into 2Q, which is why you haven't seen much margin or pricing impact thus far. Companies we also saw them start to stock up heavily on inventory before the tariffs and at the lower pause rate tariffs, which is the product you referenced that we're seeing coming in now. This is really going to help mitigate margin pressure in the second quarter that you still have this lower cost inventory flowing through. On top of this timing consideration, retailers we've just seen utilizing a range of mitigation measures, right? So whether it's canceled or paused shipments from China, a shifting production mix or sourcing exposure in the short run, particularly before the pause rate on China, and then really leaning into just whether it's product mix shifts cost savings elsewhere in the P and L in vendor negotiations. Right? They're really leaning into everything in their toolbox that they can pricing too has been talked about as something that is an option, but the option of last resort we have heard it will be utilized, but very tactically and very surgically. As we think about the back half of the year. When you put this all together, how much impact is it having on average from retailers that we heard from in the first quarter, they thought they would be able to mitigate about half of the expected tariff heads headwind, which is actually a bit better than we were expecting. Finally, I'll just comment on your comment regarding market performance. While you're right in that the overall equity and credit markets have held up well year to date, retail equities and credit have fared worse than their respective indices. What's interesting actually is that credit though has significantly outperformed retail equities, which is a relationship we think should converge or correct as we move throughout the balance of the year.

[Andrew Sheats]

So Jenna, retailers saw this coming. They've been pulling various levers to mitigate the impact you mentioned the last lever that they want to pull is price, is raising prices, which is the macro thing that we care about, the thing that would actually show up in inflation. How close are we though to kind of running out of other options for these guys? That is the only thing left is they can start raising prices.

[Jenna Giannelli]

So closer is what I would say we're likely not going to see a huge impact in 2Q, more likely as we head into 3Q and more heavily into the all important fourth quarter holiday season. This is really when those higher cost goods are going to be flowing through the P and L and retailers need to offset this as they've utilized a lot of their other mitigation strategies. They've moved what they could move, they've negotiated where they could, they've cut where they could cut. And again as this last stop it will be to try and raise price. So who's going to have the most in least success in our universe? We think it's going to be more difficult to pass along price in some of of the more historically deflationary categories like apparel and footwear outside of what is a really strong brand presence within our universe. Historically hasn't been the case also in some of the higher ticket or more durable goods categories like home goods, sporting goods, furniture. We think it'll be challenging as well here to pass along higher costs. Where it's going to be less of an issue is in our staples universe or in what we'd put as less discretionary categories like beauty, personal care, which is Part of the reason why we've been cautious on retail and neutral on consumer products when we think about sector allocation.

[Andrew Sheats]

When do you think this will show up? Is it a third quarter story, a fourth quarter story?

[Jenna Giannelli]

I think this is going to really start to show up in the third quarter and more heavily into the fourth quarter and the all important holiday season.

[Andrew Sheats]

I think that's what's really interesting about the impact of this back up to the macro Again. Returning to the big picture is I think one of the most important calls that Morgan Stanley economists have is that inflation, which has been coming down somewhat so far this year, is going to pick back up in August and September and October. And because it's going to pick back up, the Federal Reserve is not going to cut interest rates anymore this year because of that inflation dynamic. So this is a big debate in the market. Many investors disagree. But I think what you're talking about in terms of there are some very understandable reasons maybe why prices haven't changed so far, but that those price hikes could be coming have real macroeconomic implications. So maybe though, something to just close on is to bring this to the latest headlines. We're now back, it seems in a market where every day we log onto our screens and we see a new headline of some new tariff being announced or suggested towards countries. Where do you think those announcements so far are relative to what retailers are expecting? Kind of what you think is in guidance?

[Jenna Giannelli]

Sure. So look what we've seen of late, the recent tariff headlines are certainly higher or worse I think, than what investors and management teams were expecting for Vietnam. Less so, I'd say it was more in line. But for most elsewhere in Asia, particularly Southeast Asia, the rates that are set to go in effect on August 1st as we now understand them, are higher or worse than management teams were expecting. Recall that while guidance did show up in many flavors in the first quarter, so whether withdrawn guidance or lowered guidance, for those that did factor in tariffs to their guide, most were factoring in either pause rate tariffs or tariff rates that were at least lower than what were proposed on Liberation Day. Right. So what's the punchline here? I think despite some of the revisions we've already seen, there are more to come. To put some numbers around this, if we look at our group of retail consumer cohort credits, consensus expectations for calling for EBITDA in our universe to be down around 5% year over year. If we apply tariff rates as we know them today for a half year headwind starting August 1st, this number should be down around 15% year over year on a gross basis.

[Andrew Sheats]

So three times as much.

[Jenna Giannelli]

Pretty significant. Exactly. And so while there might be mitigation efforts, there might be some pricing passed along, this is still a pretty significant delta between where consensus is right now and what we know tariff rates to be today could imply for earnings in the second half.

[Andrew Sheats]

Jenna, thanks for taking the time to talk.

[Jenna Giannelli]

My pleasure. Thank you.

[Andrew Sheats]

And thank you as always for your time. If you find thoughts of the market useful, let us know by leaving a review wherever you listen, and also tell a friend or colleague about us today.

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